Summers’s Fed Put Beats Bernanke’s for Potency: Cutting Research

By Simon Kennedy -
Sep 5, 2013

A Federal Reserve headed by Lawrence Summers may give financial markets even stronger support in
times of stress than it did under Ben S. Bernanke.

That’s according to David Zervos, managing director at
Jefferies LLC in New York, who served as a visiting adviser to
the Fed in 2009. In a Sept. 3 report to clients he outlined what
he called the “Summers put,” a reference to investors’ belief
in the “Greenspan put,” the idea that the Fed under Alan Greenspan always acted to support financial markets.

“Larry is no fool and for someone who loves the art of the
bailout, this is by far the best seat in the house,” said
Zervos. “The chair of the Federal Reserve offers unprecedented
monetary and fiscal policy-making opportunities -- especially in
a time of crisis.” A put option gives investors the right to
sell their asset at a set price.

President Barack Obama needs to nominate a successor to
Bernanke, whose second term ends in January. He has identified
Harvard University professor and former Treasury Secretary
Summers and Fed Vice Chairman Janet Yellen as candidates.

As speculation swirls around Obama picking Summers, Zervos
is the latest analyst to debate what that might mean for
investors. Economists at BNP Paribas SA said in an Aug. 29
report that a Summers-led Fed would mean 10-year Treasury yields
would be 50 basis points higher than if Yellen were in charge
and economic growth as much as 0.75 percent weaker over the next
two years. Summers questioned the effectiveness of quantitative
easing in an April conference hosted by Drobny Global Advisors.

Zervos is less sure that Summers would be more “hawkish”
than Bernanke. He noted that as director of Obama’s National
Economic Council, Summers played a role in bailing out banks and
the automobile industry during the recent financial crisis. As
Treasury undersecretary in the 1990s, Summers also helped craft
a rescue plan to ease Mexico’s financial crisis.

Summers’ academic work also “always found a crucial role
for government intervention,” said Zervos.

By contrast, Bernanke “rarely stepped in pre-emptively
with policy bailouts or backstops,” so is perhaps less
supportive of markets than Summers, he said. Summers could also
profit from Bernanke’s approach to policy making, in which a
“creative” reading of its statute allowed the Fed to pursue
more aggressive efforts in establishing currency swaps, the Term
Asset-Backed Securities Loan Facility and other initiatives.

Summers, though, may be less likely than Bernanke to use
quantitative easing-style policies to fight deflation, Zervos
said. Instead, a Summers-led Fed may prefer to start a program
in which the Fed helps support private sector lending, he said.

“In that sense, I actually think a Summers put will be
more potent and have fewer nasty side effects than a Bernanke
put,” Zervos said. “I’m a buyer of the Summers put.”

Tracking the extent to which users typed “recession” and
“jobs” into Google could have predicted Canada’s 2008-2009
recession by as much as three months in advance, Greg Tkacz,
chairman of the department of economics at St. Francis Xavier
University in Antigonish, Nova Scotia, wrote in a report
published Sept. 4.

While such high-frequency indicators are in their infancy,
Tkacz said Internet search engines will serve as useful inputs
for monitoring economies.

“Their timeliness can potentially help policy makers
recognize downturns as they occur and obtain a better measure of
their severity in real time, thereby helping to devise
appropriate policy responses,” he said.

* * *

The Fed’s communication powers are fading.

In a study of so-called forward guidance, economists at the
Fed Bank of Kansas City found a weakening in the response of
both stock prices and bond yields on days when the central bank
made major monetary policy announcements.

For bond yields, the reason may be the expectation of
greater stability in policy. The response of stocks may have
diminished because investors previously revised down their
economic outlook when the Fed indicated it would be more
accommodative, said authors Taeyoung Doh and Michael Connolly in
a report published this week.

“As a result, the stimulus from such policy announcements
was weakened,” they said.

* * *

The Fed’s unconventional monetary policy announcements of
2008 to 2009 had significant effects abroad by reducing
international long-term bond yields and the value of the dollar.

That’s the finding of an August working paper by St. Louis
Fed Bank economist Christopher J. Neely that studied the
reverberations of the Fed’s decisions to signal its rate outlook
and buy long-term securities. The paper’s release is apt given
the debate among policy makers about how much the Fed will
influence other markets when it begins to pull back aid.

The stimulus actions “significantly reduced” the 10-year
bond yields of Australia, Canada, Germany, Japan and the U.K.,
Neely said. Australia’s fell as much as 63 basis points. The
dollar also dropped against the currencies of these countries.
Each of the countries’ central banks also eased their interest
rates during that period.

“These changes closely followed announcements and were
very unlikely to have occurred by chance,” Neely said.

His research proved that “central banks are not
toothless” when benchmark interest rates have reached zero. He
suggested central banks also should “coordinate their
unconventional policies to avoid contradictory or overly
stimulative effects.”

* * *

One of the first economists to warn an asset-price bubble
was forming ahead of the financial crisis is now declaring there
is no science to monetary policy -- and it’s being relied on too
much to revive the world economy.

In a paper published last week by the Fed Bank of Dallas,
William White said the fashions of economic theory and changes
in the financial system help explain how monetary policy has
changed over time. The knowledge of science, by comparison,
evolves slowly and because of external realities.

“Looking back at the conduct of monetary policy over the
last 50 years, one must be impressed by the changes observed in
every aspect of the business,” said White.

White retired in 2009 from the Basel, Switzerland-based
Bank for International Settlements, having warned prior to the
2008 financial crisis that central banks might need to raise
interest rates to combat asset bubbles. He now chairs the
Economic Development and Review Committee at the Paris-based
Organization for Economic Cooperation and Development.

One lesson from the vagaries of economic management is that
policy makers may not be able to easily separate price and
financial stability challenges, he wrote. Short-term aims can’t
be addressed without thinking about longer-term fallout in
markets and economies, he said.

“Monetary policy remains more art than science and the
artists remain all too human and fallible,” White said. “The
conclusion that we need to widen the array of policy tools
directed to economic stabilization clearly applies to the
prevention or moderation of the next crisis. It applies,
however, equally or even more strongly to the management of the
current one.”

* * *

Gamblers may be better at predicting the outlook for the
U.K. economy than Bank of England Governor Mark Carney.

That’s the bet of the London-based Adam Smith Institute, a
research group dedicated to the free market economy. Noting that
the U.K. central bank has often gotten its economic forecasts
wrong, the institute last week united with Paddy Power Plc to
create two betting markets that let members of the public wager
on the performances of U.K. inflation and unemployment.

The theory is that bookmaker odds are more reliable than a
handful of expert opinions because betting markets collect the
judgments of thousands of people. Moreover, gamblers have a
strong financial incentive to bet in a dispassionate way,
washing out individual biases, Sam Bowman, the institute’s
research director, said in an Aug. 28 blog.

“If these markets catch on, the government should consider
outsourcing all of its forecasts to prediction markets instead
of expert forecasters,” he said.